With housing prices still coming down in many regions and analysts predicting a long housing recovery period, you might do better investing your money in the stock market rather than paying off your mortgage. Still, many homeowners I know have taken advantage of the low interest rates to refinance their mortgages and move into a 15-year mortgage from a 30-year so they can pay off their home faster.
Like many people, they feel that the more equity they have in their home, the better. And in most cases, they’d be right. But, as Adam Bold, founder of the Mutual Fund Store, says in an article he wrote for Yahoo Finance, people shouldn’t rush to pay off their mortgage because it doesn't make financial sense.
Bold, who also has his own radio show, used the example of a man who planned on using half of his $100,000 mutual fund investment to pay off the remaining $50,000 on his home mortgage. Rather than pay off the mortgage, Bold recommended he keep his money invested and here’s why.
The man has a 5 percent interest rate on his mortgage, and the interest he pays can be deducted when he does his tax return. Depending on his tax bracket, his interest cost leaves him with a net mortgage cost of roughly 3.6 percent (or $1,800) per year after taxes. If he keeps the $50,000 invested in the stock market rather than paying off his mortgage and earns the stock market's long-term average return of 10 percent or more, he would have an annual gain of $5,000. Subtract the $1,800 mortgage interest cost from $5,000 earned by staying invested, and he could end up $3,200 ahead. If he continues to invest $3,200 per year over the next five years, he can accumulate $16,000 or more, money he wouldn't have by paying off his mortgage.
Bold says that the other reason people shouldn't pay off their mortgage is more emotional in nature. Many people believe they'll attain peace of mind when they pay off their mortgage. They might share the Depression-era belief that the government can't take their house away if they pay off their loan. But Bold believes that any peace of mind is outweighed by the potential benefits of keeping the money and investing it.
According to Bold, if a person uses investment money to pay off that loan, it may leave that person with much less money when it's really needed in future years. That could be a costly mistake because it may not offer the person the luxury of time to replenish his nest egg.
Besides, with mortgage rates on the rise recently, this is not the time to be in a hurry to pay off a mortgage. Bold says he’s hopeful that many homeowners were able to benefit in recent years by refinancing their loans as 30-year fixed mortgage rates fell, including a period of time in 2010 when rates were below 4.5 percent. Their interest costs should be very low going forward.
Bold says mortgage debt is okay to have, because equity in the home is being built as the loan is paid down. For most people, their home will always be a part of their net worth, even if they don't pay off the mortgage. And low-interest mortgages allow them to expand their wealth by investing money they have because they didn't pay off their mortgage.
So, Bold encourages people to keep their mortgage and instead, enjoy the fruits of investing their extra money. When considering net worth, whether it's increased home equity or a larger investment account, it's still net worth. With investments, they have a chance to grow. With home equity, the interest savings are the only upside.
Adam Bold is not only the founder of The Mutual Fund Store, which provides fee-only investment advice, he’s also the author of The Bold Truth about Investing and the Chief Investment Officer of The Mutual Fund Research Center, an SEC registered investment adviser.